ASC 718 Example: A Practical Guide to Stock Compensation Reporting
Let’s explore an ASC 718 example, showing how company can follow the ASC 718 accounting guidelines to record stock options offered to an employee.
In the US, ASC 718 accounting guidelines govern how we report stock-based compensations. Compliance with ASC 718 stock compensation reporting guidelines is an important step in maintaining transparency with your stakeholders and ensuring tax compliance.
In this article, we will see how Finnova Venture must follow the ASC 718 accounting guidelines to record stock options offered to one of its employees. We will also discuss some challenges you may face in following ASC 718 and the best practices to address them.
ASC718: Case study
Let’s explore an ASC 718 example, showing how Finnova Venture follows the ASC 718 accounting guidelines to record stock options offered to an employee.
- Name: Finnova Venture
- Stage: Series A funded startup
- Offerings: Provides investment opportunity leads and exit opportunity leads to angel investors, venture capitalists (VCs), and private equity (PE) firms
- Necessary capability: Researching and building a network of investors and founders is vital to their operations.
Based on a recent 409A valuation, we know that the fair market value (FMV) of Finnova Venture’s shares is $10.43. 2 years ago, in 2022, Finnova Venture awarded stock options to 20 employees. The details of these option plans are as follows:
| Employee name | Options | Exercise price (in $) | Vesting period |
|---|---|---|---|
| Emma Priestley | 700 | $1 | 4 |
| Tim Brook | 1,500 | $2 | 3 |
| Dan Walker | 1,100 | $2 | 3 |
| Andrew Marsh | 1,100 | $2 | 4 |
| Elliot Berger | 1,300 | $1 | 4 |
| Fernando Urkijo | 1,500 | $1 | 3 |
| Indika Ramesh | 700 | $2 | 3 |
| Lawrence Evans | 1,300 | $2 | 3 |
| Lindsey Rostron | 1,300 | $1 | 4 |
| Marco Cattai | 1,200 | $1 | 4 |
| Megan Pantelides | 1,500 | $2 | 3 |
| Niamh Corbett | 1,100 | $1 | 4 |
| Sandra Mitchell | 1,500 | $2 | 3 |
| Suzi Beeze | 900 | $2 | 4 |
| Tom Newman | 900 | $2 | 3 |
| Abigail Lamb | 1,200 | $1 | 4 |
| Amelia McCormack | 700 | $1 | 3 |
| Anna Humphreys | 700 | $1 | 4 |
| Ben Wiggins | 1,500 | $1 | 4 |
| Christopher Coldwell | 900 | $2 | 4 |
Finnova Venture must record these options in its books per ASC 718 to ensure transparent bookkeeping and tax compliance. To do so, they will need to take the following steps:
- Calculate the share options vested and to be expensed in the current period
- Find the value of said share options which will be the current period expense
- Find the total expense to the company
- Make journal entries for the compensation expense and the additional paid-in capital
- Make disclosures regarding the stock options granted
Step 1: Calculating the shares to expense
Under the ASC 718 accounting guidelines, companies use the straight-line or the FIN28 method to calculate the shares expensed in the current period.
The straight-line method involves dividing the options by the years in the vesting schedule. In the FIN28 method, we assume that each set of options is a new award and follows its own standard vesting schedule. So, the stock options awarded in year 1 will get vested over 1 year, the stock options awarded in year 2 will get vested over 2 years, and so on.
Let us try out both methods to find out how many of Emma Priestley’s share options were vested in the current period.
Straight-line method
Number of options to be allocated each year = Total number of options ÷ Years in the vesting schedule
= 700 ÷ 4 = 175
So, for every year in the vesting schedule, Finnova Venture must record the expense of 175 options.
Straight Line Method
For every nth award, the vesting schedule will be n number of years. For every year in the vesting schedule, the number of stock options from the nth award to be allocated will be stock options in the nth award divided by n.
In this manner, we must calculate the number of stock options to be recorded from each award.
Now, let us look at the actual figures. While we do that, we will also add the figures for each year to find the total stock options allocated in a year.
Emma Priestley was awarded these stock options 2 years ago in 2022. Since we are preparing financial statements for year 3, we must expense the 102.08 stock options that got vested this year.
To keep things simple, in this case study, we will use the straight-line method.
So, the number of stock options vested and to be expensed for the current period will be as follows:
| Employee name | Options (A) | Vesting period (B) | Options to be expensed (C = A ÷ B) |
|---|---|---|---|
| Emma Priestley | 700 | 4 | 175 |
| Tim Brook | 1,500 | 3 | 500 |
| Dan Walker | 1,100 | 3 | 366.67 |
| Andrew Marsh | 1,100 | 4 | 275 |
| Elliot Berger | 1,300 | 4 | 325 |
| Fernando Urkijo | 1,500 | 3 | 500 |
| Indika Ramesh | 700 | 3 | 233.33 |
| Lawrence Evans | 1,300 | 3 | 433.33 |
| Lindsey Rostron | 1,300 | 4 | 325 |
| Marco Cattai | 1,200 | 4 | 300 |
| Megan Pantelides | 1,500 | 3 | 500 |
| Niamh Corbett | 1,100 | 4 | 275 |
| Sandra Mitchell | 1,500 | 3 | 500 |
| Suzi Beeze | 900 | 4 | 225 |
| Tom Newman | 900 | 3 | 300 |
| Abigail Lamb | 1,200 | 4 | 300 |
| Amelia McCormack | 700 | 3 | 233.33 |
| Anna Humphreys | 700 | 4 | 175 |
| Ben Wiggins | 1,500 | 4 | 375 |
| Christopher Coldwell | 900 | 4 | 225 |
Step 2: Finding the value of the share options to be expensed
For the next step, we will use the Black-Scholes model which is commonly used to estimate the value of derivatives like options and its inputs are the value of the underlying asset, strike price, time until expiry, risk-free interest rate, volatility, and the expected annual dividend yield.
The Black-Scholes formula for option pricing is:
Call option price = S × N(d1) – K × e-rt × N (d2)
Here:
- S = Value of the underlying asset which will be $10.43 in this case.
- K = Strike price
- r = Risk-free interest rate
- t = Time to maturity which is the vesting period minus years passed
- N = Normal distribution
- σ = Volatility
- d1 = ln(S/K) + (r+σ2/2) × t / σ × √t
- d2 = d1 – σ × √t
We will assume that the risk-free interest rate is 6% and we will calculate the volatility as the average volatility of 7 listed companies which are similar to Finnova Venture. For the volatility calculation, we will consider a period of 3 years.
| Company | Market Cap (in $) | Volatility |
|---|---|---|
| Investora Connect | 50.45 million | 40.46% |
| VentureHorizon | 171.80 million | 21.93% |
| Capital Nexus | 336.40 million | 18.89% |
| EquityFlow Advisors | 52.25 million | 18.00% |
| FoundersLink | 103.13 million | 11.87% |
| Summit Equity Partners | 162 million | 10.38% |
| Catalyst Ventures | 179.16 million | 10.22% |
Note: All companies mentioned are fictional.
So, volatility = Average volatility of Investora Connect, VentureHorizon, Capital Nexus, EquityFlow Advisors, FoundersLink, Summit Equity Partners, and Catalyst Ventures
= (40.46%+21.93%+18.89%+18.00%+11.87%+10.38%+10.22%) ÷ 7 = 18.82%
Now, let us apply the Black-Scholes formula to the data we have and find the fair value of each option.
| Employee name | K | t | ln(S/K) | (r+σ2/2) × t | σ × √t | d1 | d2 | e-rt | N(d1) | N (d2) | Fair value | Expense |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Emma Priestley | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $1,670.04 |
| Tim Brook | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $4,273.24 |
| Dan Walker | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $3,133.71 |
| Andrew Marsh | $2 | 2 | 1.65 | 0.16 | 0.27 | 6.79 | 6.52 | 0.89 | 1 | 1 | $8.66 | $2,380.44 |
| Elliot Berger | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $3,101.50 |
| Fernando Urkijo | $1 | 1 | 2.34 | 0.08 | 0.19 | 12.87 | 12.68 | 0.94 | 1 | 1 | $9.49 | $4,744.12 |
| Indika Ramesh | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $1,994.18 |
| Lawrence Evans | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $3,703.47 |
| Lindsey Rostron | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $3,101.50 |
| Marco Cattai | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $2,862.92 |
| Megan Pantelides | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $4,273.24 |
| Niamh Corbett | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $2,624.35 |
| Sandra Mitchell | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $4,273.24 |
| Suzi Breeze | $2 | 2 | 1.65 | 0.16 | 0.27 | 6.79 | 6.52 | 0.89 | 1 | 1 | $8.66 | $1,947.64 |
| Tom Newman | $2 | 1 | 1.65 | 0.08 | 0.19 | 9.19 | 9 | 0.94 | 1 | 1 | $8.55 | $2,563.94 |
| Abigail Lamb | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $2,862.92 |
| Amelia McCormack | $1 | 1 | 2.34 | 0.08 | 0.19 | 12.87 | 12.68 | 0.94 | 1 | 1 | $9.49 | $2,213.92 |
| Anna Humphreys | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $1,670.04 |
| Ben Wiggins | $1 | 2 | 2.34 | 0.16 | 0.27 | 9.39 | 9.13 | 0.89 | 1 | 1 | $9.54 | $3,578.65 |
| Christopher Coldwell | $2 | 2 | 1.65 | 0.16 | 0.27 | 6.79 | 6.52 | 0.89 | 1 | 1 | $8.66 | $1,947.64 |
Step 3: Finding the total expense to the company
In this step, we just need to multiply the fair value of all options by the number of options vested in the current year and sum these values for all employees to find the total expense.
| Employee name | Stock options vested | Fair value | Expense |
|---|---|---|---|
| Emma Priestley | 175 | $9.54 | $1,670.04 |
| Tim Brook | 500 | $8.55 | $4,273.24 |
| Dan Walker | 366.67 | $8.55 | $3,133.71 |
| Andrew Marsh | 275 | $8.66 | $2,380.44 |
| Elliot Berger | 325 | $9.54 | $3,101.50 |
| Fernando Urkijo | 500 | $9.49 | $4,744.12 |
| Indika Ramesh | 233.33 | $8.55 | $1,994.18 |
| Lawrence Evans | 433.33 | $8.55 | $3,703.47 |
| Lindsey Rostron | 325 | $9.54 | $3,101.50 |
| Marco Cattai | 300 | $9.54 | $2,862.92 |
| Megan Pantelides | 500 | $8.55 | $4,273.24 |
| Niamh Corbett | 275 | $9.54 | $2,624.35 |
| Sandra Mitchell | 500 | $8.55 | $4,273.24 |
| Suzi Beeze | 225 | $8.66 | $1,947.64 |
| Tom Newman | 300 | $8.55 | $2,563.94 |
| Abigail Lamb | 300 | $9.54 | $2,862.92 |
| Amelia McCormack | 233.33 | $9.49 | $2,213.92 |
| Anna Humphreys | 175 | $9.54 | $1,670.04 |
| Ben Wiggins | 375 | $9.54 | $3,578.65 |
| Christopher Coldwell | 225 | $8.66 | $1,947.64 |
| Total expense | $58,920.68 |
Step 4: Journal entry
In this step, we just need to record the following journal entry.
| Particulars | Debit | Credit |
|---|---|---|
| Stock-based compensation expense | $58,920.68 | - |
| Additional paid-in capital | - | $58,920.68 |
Step 5: Disclosures
In the final step, we must share a summary of all stock options-related transactions from the past year.
| Stock options | Shares | Weighted Avg. FV/share | Total FV | Weighted Avg. Exercise Price/share | Total exercise price | Intrinsic value/share | Total intrinsic value | Term Expired (years) | Wtd. Average Remaining Contractual Term (years) |
|---|---|---|---|---|---|---|---|---|---|
| (i) Outstanding as of 2022-1-1 | 13,083 | $9.01 | $117,877.80 | $1.54 | $20,147.80 | $7.47 | 97,730 | 2 | 1.55 |
| (ii) Granted during period | 6,542 | $9.01 | $58,920.70 | $1.54 | $10,074.70 | $7.47 | $48,868.70 | 3 | 0.55 |
| (iii) Forfeited during the period | - | - | - | - | - | - | - | - | - |
| (iv) Exercised during the period | - | - | - | - | - | - | - | - | - |
| (v) Expired during the period | - | - | - | - | - | - | - | - | - |
| (vi)Outstanding as of 2022-12-31 | 19,625 | $9.01 | $176,821.30 | $1.54 | $30,222.50 | $7.47 | $146,598.80 | 3 | 0.55 |
| (vii) Exercisable at the end of the period | 19,625 | ||||||||
| Unvested as of 2022-1-1 | 9,517 | ||||||||
| Unvested as of 2022-12-31 | 2,975 |
ASC 718 challenges and best practices
Some of the challenges that you may encounter in following ASC 718 accounting guidelines, and the best practices to deal with said challenges are:
| Challenge | Best practices |
|---|---|
| Measuring the fair value of the company | When you use a reputable option pricing model like the Black-Scholes model, you will find a lot of helpful documentation and examples published by recognized institutions and professionals. If you are not familiar with these models, consider relying on Eqvista, a valuation professional that has served more than 15,000 companies. |
| Estimating the impact of stock option forfeiture | Firstly, you must periodically check the status of stock options. Then, whenever employees forfeit their stock options, you must estimate the value of those stock options and make adjustments accordingly. |
| Allocating total compensation over the vesting period | If you find the FIN28 method of ASC 718 accounting guideline too complex to apply, simply use the straight-line method. Set a reminder to calculate the expense based on the new share price whenever you record the expenses in your journal and ledgers. |
| Modifications and repricing | First, list all the changes in the stock option plan. You must record the changes in key details like exercise price, and vesting schedule which are likely to affect the stock option value. Then, calculate the change in value of stock options and make the adjustments. |
Let Eqvista Handle Your ASC 718 Needs
When you record stock compensations based on ASC 718 accounting guidelines, you must carefully calculate the fair value and expense allocation over the vesting schedule and transparently disclose the details of the stock option plan.
You can troubleshoot some of the challenges in following ASC 718 accounting guidelines by being methodical in your approach and relying on experts.
If you need any assistance following ASC 718, do not hesitate to reach out to Eqvista. We provide reliable ASC 718 services so you can focus on what really matters for your business.
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